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1. Some economist criticized the comparative advantage principle, contending that it may have helped developed countries maintain relatively advanced technology and industry compared to developing countries. Can you explain how Trade based on Comparative Advantage could have helped maintain the income inequality among different countries globally?
International trade is essential for developing countries in order to achieve sustainable growth. This flow of goods and services will significantly affect economic growth and decrease poverty. (Goldberg and Pavnick, 2007b). But poverty reduction has not been even among all of the developing countries, especially least developed countries (LDC) and the countries in sub-Saharan Africa that were not able to diversify their production and exports in order to maintain in the competition and they are facing low growth and persistent poverty.
There has been reseaches done on the matter of income inequality and conflicting results has been shown. Debate is still going on that whether income inequality has been decreased or increased in the past two decades. (Sala-i-Martin (2006) and Atkinson and Brandolini, 2010) Even though this debate has been unsolved, income inequality remained high. According to figure 1 more than 80% of LDC’s population lives under $2 a day.
In 2004, UNCTAD’s report demonstrated that in LDC’s with the most open and most close trade structure, incidence of poverty has been increased dramatically. On the other hand, in between, poverty has been higher in the countries that had liberalized their trade regimes in comparison to countries that liberalization was happening slowly. Six years later same study has been done by George resulted that complete liberalization cold really hurt LDCs and sub-Saharan Africa’s production and employment and it can also damage environment. Full liberalization of agriculture could lead to an increasing dependence on food imports and a rise in poverty in most places.
According to Feenstra 2008, trade liberalization has a significant impact on income distribution by encouraging the adoption of skill-biased technical change in response to increased foreign competition, or to the increased globalization of production. Foreign Direct Investment (FDI) flows typically follow trade liberalization and that is why the skill differential widens.
2. Can governments shape or distort comparative advantage? Can such policies be labeled as “protectionists”? In your opinion did international trade destroy jobs in the US and reduce wages? Does Globalization affect job security?
Yes they can. According to Lin in Lin article in 2009, governments are willing to help and support industries that may be profitable and efficient in the future in the “infant” phase, such as new technologies with a high potential of develop and growth.
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Sometimes identifying economic potentials are difficult so may instead focus on reducing costs and improving conditions horizontally for all sectors. In the indirect section, government policies are not aimed to target specific industry or segment, but they are made to compensate market failures. “These policies has been made in order to reduce corruption, remove unnecessary barriers exists in market transactions enforce property rights, assure macroeconomic stability, build transport and communication infrastructure, support mass education, and assist technological advance. At this point, realizing and perceiving the potential requires initial support from government, including protection from foreign competition.” (Trade Primer: Qs and As on Trade Concepts, performance and policy, 2013)
Protecting domestic industries will help them to develop their comparative advantage and to benefit from economies of scale. Firms within the industry will take advantage of this protectionism and invest in real and human capital and developing their own skills. Once these goals have been achieved there is much less need for protectionism. Protectionism might be needed in the sunset industries, or declining industries. Government can help and support these industries to slow their decline or help them boost their growth again. Strategic and non-renewable industries should be protected too, since these resources are accounted as most valuable comparative advantage.
A number of other hypotheses have been competing with comparative advantage for policy makers’ attention:
Strategic trade policy literature Krugman, 1987 Emphasized economies of scale and provided a theoretical case for government intervention
Economic geography literature Krugman and Venables, 1995 Emphasized factor mobility and the fact that the structure and volume of trade can be determined by geographic agglomeration of economic activity based on initial conditions and trading costs
Business literature Porter 1990 Posits that it is not so much the comparative costs that should be the focus of country’s economic policies but rather the competitive advantage, or the ability to perform at a higher level of productivity than others in the same industry or market
World is flat Freidman, 2005 Commercial level playing field where historical and geographical divisions are becoming increasingly irrelevant and all competitors have an equal opportunity
Development Policy Review Debate Lin and Chang, 2009 Summarizes these various arguments and reveals that the debate on policy-relevance of comparative advantage is still at the center of policy considerations
International trade creates and destroys jobs based on country’s economic situation. Trade can be a very powerful support source for industries with a growing comparative advantage and as a result it will create jobs and reduces poverty will occur. By opening the market, workers in the exporting industry will enjoy the higher job security and significant payment; in addition, by lowering import barriers countries will benefit from lower cost and increased variety of choices. So they can allocate more resources to areas they have comparative advantages. On the other hand, opening up country’s markets will bring up some new challenges, depending on how strong industries are, and if they can compete successfully with foreigners by producing more efficiently and by diversifying their products. Some industries are not able to compete and therefor lots of workers will lose their jobs. Government policies play a crucial role in this section where they can apply adjustment policies offering social safety nets, better educational facilities and other policies that can create job opportunities for displaced workers.
Generally trade creates job opportunities in exporting industries and destroys jobs when imports replace domestic production, since the past decade US faced trade deficit and more jobs have been displaced rather than being created. But trade can offset some of the job losses, when trade deficit grows, US trading partners will invest those dollars in the US economy and this will increase the supply fund available for US businesses which will decrease the interest rates and it is possible to see some job growth in the interest-sensitive industries like housing.
Lots of studies has been done to examine job impacts of trade in recent years by evaluating and acomparing job opportunities lost due to import in comparison to jobs created by exports, but the exact result never came out. “In the late 1990s, for example, manufacturing jobs were lost to trade while construction jobs (at least partially spurred by foreign capital inflows) boomed. In the early 2000s, conversely, manufacturing jobs due to trade faster than any other industry (even interest-sensitive industries) could replace them.” (Josh Bivens, 2008)
Integration of US economy with low-wage trading partners will definitely affect American workers’ wages; furthermore, it will contribute significantly to increase income inequality in U.S. economy. For instance, in the case of U.S. and China, where both countries reduced their trade barriers in order to specialize in their most efficient industries. Today U.S. is exporting financial services and aircraft while importing electronics and apparel, which will increase the profits and high-end salaries and decrease middle and down level workers’ wages. “A reasonably cautious estimate is that between 1973 and 2006, global integration lowered the wages of U.S. workers without a four-year college degree (the large majority of the U.S. workforce) by 4%. College-educated workers saw 3% gains from trade, so inequality increased in this time as well.” (Josh Bivens, 2008)
3. Is trade deficit a problem for the US economy? How long in your opinion can the US keep running trade deficits? What are the different types of trade policies that the US can initiate to reduce trade deficit?
According to U.S. Census Bureau, trade deficit in goods and services declined about 11.8 percent ($63.1 billion) in 2013. U.S. goods trade deficit in petroleum goods has been decreased about 20 percent, but U.S. faced a 20.7 percent increase in trade deficit for non-petroleum goods which will clarify a displacement of manufacturing jobs over the last ten years. This growth in trade deficit for non-petroleum goods means that demand for US made goods and services has been reduced dramatically. Most of these goods are manufactured products that include 85 percent of American exports. China and other members of TPP (Trans-Pacific Partnership) are the main reason of this trade deficit growth. In 2013, US faced 1.1 percent growth in trade deficit with China and 1.4 percent with TPP members. (Figure A)
Some economists believe that trade deficit is the main route of US unemployment problem. White house estimates that by exporting $1 billion, 5,000 jobs can be created, however, by importing $1 billion economy will lose about 9,000 jobs. They believe that actually “free” trade has not been really free for American economy because since the initial step of implementing NAFTA trade deficit has been growing and jobs has been lost.
U.S. trade deficit with TPP countries, 2000–2013
*Annual data for 2013 is estimated based on year-to-date trade through November 2013.
Note: Export data in this figure exclude transshipments.
Source: Author's analysis of U.S. International Trade Commission Trade DataWeb (USITC 2014)
As long as foreign investors find America a safe and attractive place for their investments trade deficit can go on. US trade partners are willing to invest their surplus capital in the U.S. as a country with bright future, great productivity growth and perfect place for efficiently allocating capital. So, as long as they are buying and holding U.S. assets, particularly government securities and other financial assets U.S. has no problem to finance its trade deficit. Due to the fact that China is really a fast growing country but really riskier than US because of their weak financial systems and infrastructure, US gives them a chance to diversify their investment. “Their decision relies on relative rates of return on investments, interest rates on U.S. financial assets, actions by foreign central banks, and the savings and investment decisions of businesses, governments, and households.”
Governments use trade policy to provide a framework for their international trades and to shape and improve the process of the movements of their exports and imports across the national borders. Trade policies play a crucial role in building US business infrastructure by improving distortions and addressing business issues. These policies can be categorized into four groups. First is to open worldwide markets for US exporters through one of these approaches: “bilateral negotiations and trade/investment agreements, through establishing free trade agreements, and through multilateral negotiations under the WTO.” Second policy is the protectionism meaning to protect domestic industries from foreign competitors by imposing tariffs or subsidizing local industries with tax credits or direct payments, third is to promote US exports and finally protect dollar from depreciating because of foreign manipulation in order to gain competitive advantage. Manufacturing section is the most hurt industry by currency manipulation when cost of imports is artificially lowered while export cost has been raised. This will result into goods trade deficit, which will displace US jobs. One of the main areas of trade policy that US government should really focus on is to solve currency manipulation problem. Economists have predicted that goods trade deficit can be decreased about $190 billion in three years if government resists currency manipulations. According to a study done by Robert E. Scott, Helene Jorgensen, and Doug Hall in February 7, 2013, if this action completes by government these results will happen: exact word from their article has been provided below:
• Create between 2.2 million and 4.7 million U.S. jobs (equal to between 1.4 percent and 3.0 percent of total nonfarm employment)
• Reduce the national unemployment rate by between 1.0 and 2.1 percentage points
• Create about 620,000 to 1.3 million manufacturing jobs (27.5 percent of all jobs created by eliminating currency manipulation)
• Increase U.S. GDP by between $225.0 billion and $473.7 billion (an increase of between 1.4 percent and 3.1 percent)
• Shrink the federal budget deficit by between $78.8 billion and $165.8 billion (reductions that would continue as long as the trade balance remained stable), as growth in output expands tax receipts and reduces safety net payment
4. Who benefits from trade liberalization agreement? Who you think loses? Does integration helps or hurts in trade liberalization.
In order to have a sustainable international trade all the countries involved in the trade should win. In the trade liberalization agreement the world economy benefits including rich and poor countries. In the perfect world one could say that income and profits gain from international trade should be reinvested in the industries that have a comparative advantages globally, but in reality there are some industries that will not be able to make necessary adjustments due to lack of infrastructure, financial means and structural barriers. After barriers are removed and markets are open domestic industries have to adjust themselves by producing qualified and diverse products and take advantage of opportunities became available because of international trade to benefit from international trade, otherwise they will not gain as much as other countries and they will lose the competition.
Furthermore, theories suggest that in the long run, import competing industries will disappear and their resources will allocate to the industries that have comparative advantage with efficient production. But in reality, governments sacrifice their economic evolution by protecting these industries by imposing tariffs or quotas.
There are some benefits associated with economic integration. Members of this integration will benefit from more choices of goods and services available for them, they can enjoy lower cost and improved services due to lower tariffs, and they are encourages for more trades in between members. Global economic integration encourages trade liberalization in order to achieve more open and expanded markets. By the integration countries can collaborate more on new technologies and inventions, more investments can be done globally and job opportunities will increase. Developing countries are the main winners of global economic integration. They can take advantage of this opportunity to build effective and efficient infrastructure in order to build foundations for introducing themselves as a developed country. On the other hand, there are some disadvantages. Trade barriers will be increased against countries that are not a member of integration. Controls and regulations on trade, monetary and fiscal policies have to be given up as long as integration increases, which may arise domestic issues.
5. Why trade deficits and foreign investments are politically sensitive issues and perceived to be by some individuals an economic problem? Now present the counter arguments that are supportive of laissez faire trade policies. Present examples from the real life and your reading of international trade that support your essay.
With Trade deficits and foreign investments there are usually cries for protectionism. The question is why should policy planners resist implementing protectionist policies and depend on Laissez faire trade policies.
There is no exact answer that could address this issue. Both of these theories have advantages and disadvantages. In the laissez faire trade, protectionism argues that all countries’ economies around the world are competing against each other, therefore governments have to protect domestic industries, jobs and living standards by imposing trade barriers in order to prevent cheap foreign goods destroy countries’ advantageous that have been built over time. On the other hand, free trade argues that protectionism governments protect industries that are inefficient and unprofitable, which will hurt productive and efficient industries as well as consumers who have to buy more expensive goods and services. Proponents of laissez faire trade think that every country should benefit from open markets. They believe that since free trade recognizes individual rights such as liberty, property rights and the pursuit of happiness, it’s the only uncontrolled, unregulated and moral economic system. Proponents of protectionism believe that in order to concentrate on domestic industries health governments should interfere to protect the economy from foreign competitors and respond to market failures.
There was clothing manufacturing in Australia that produced most of the clothing and footwear worn domestically and it also exported. In 1980’s, after Labor government reduced tariffs within 5 years the entire industry was dead. There are two arguments here: people who believe in free trade would say that this industry was not efficiently productive and profitable, that without government support the whole industry failed. Protectionism will argue that government has destroyed one of the most important local industries by taking Australian jobs and hand it over to other countries. (Workers of this plant were not moved to another sector and unemployment grew really fast in this area)
Automotive industry is one the most supported industries in Australia by employing more than 45,000 people and receiving 10 percent of all government assistance. Some Australian economists believe that by calculating assistance per capita, Australia has one the lowest ratio in the world, but others believe that this calculation ignores the size of country’s automotive manufacturing sectors, so they say that on a per vehicle basis Australia is among the mid ranking or highest ranking in the world. Toyota, Ford and GM are three main manufacturers who are going to leave the country by 2017, because they are all saying that it has become so expensive to produce a car in Australia in comparison to other countries. They estimate that producing each car in this country cost them $4,000 more than any other countries. "We did everything that we could to transform our business, but the reality is that there are too many factors beyond our control that make it unviable to build cars in Australia," said Max Yasuda, the CEO of Toyota Australia. By exiting Toyota from Australia 2,500 jobs will be lost, so is it good for the industry to open the market and reduce tariffs or the best solution is to continue protecting domestic industry? Proponents of free trade believe that they are paying more than usual and even if they do not buy a car manufactured in Australia they still have to pay for one, on the other hand, protectionism proponents that by importing cars, Australian are not benefiting because they are importing skills, knowledge and job from other countries and all of them are going overseas.
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Cutting Annual Trade Deficit By $300 Billion Would Increase GDP, Create Jobs. (n.d.). Retrieved from http://www.moneynews.com/Peter-Morici/trade-GDP-currency-China/2013/08/05/id/518672
Toyota exit heralds end of Australia's auto industry - Feb. 10, 2014. (n.d.). Retrieved from http://money.cnn.com/2014/02/10/autos/toyota-australia/
Trade, jobs, and wages | Economic Policy Institute. (n.d.). Retrieved from http://www.epi.org/publication/ib244/
The U.S. Trade Deficit and Jobs: The Real Story | Cato Institute. (n.d.). Retrieved from http://www.cato.org/publications/free-trade-bulletin/us-trade-deficit-jobs-real-story
U.S. Trade Deficit Fosters Unemployment | Economy In Crisis. (n.d.). Retrieved from http://economyincrisis.org/content/lack-jobs-due-our-massive-trade-deficit
Upon Hope: Free Trade Versus Protectionism. (n.d.). Retrieved from http://uponhopeblog.blogspot.com/2013/12/free-trade-versus-protectionism.html
Wayne M. Morrison, (2014), China-US Trade Issues.